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Rating agencies actually do matter, and the S&P downgrade of Spanish government debt yesterday is bad news prime minister Mariano Rajoy’s crisis stricken government.The two-notch downgrade of Spain’s credit rating to BBB- puts it only one downgrade away from sub-investment grade territory, and S&P said, on top of that, that the rating outlook is negative.
Spain is still under review by rating agency Moody’s – which also has Spain rated only one notch above junk – for further downgrades. The assessment is expected to conclude by the end of October.
Consequently, the relative calm we’ve seen in Spanish bond markets since the ECB hinted at its big rescue plan at the end of July may finally be drawing to a close.
“Even the prospect of seeing the two major agencies rating Spain below investment grade will lead to widespread selling over the coming month,” Societe Generale rates strategist Ciarán O’Hagan wrote in a note this morning.
Citi rates strategist Robert Crossley explained in a note that if Spain is lowered below investment grade by two agencies, investable indexes that hold Spanish sovereign debt will have to sell their holdings.
If that happens, it could lead to a scary situation in the Spanish bond market, Crossley writes:
How much index-tracking money is invested in Spain?
Approximately, if $1.5-2t is invested in the WGBI, and Spain is 2.5% of that (or 10% of the EGBI), then that translates into €45-65bn invested in Bonos by funds benchmarked to the WGBI. But the important point is not the arithmetic: it is that the fear of any significant marginal flows could quickly become self-fulfilling.
And SocGen’s O’Hagan thinks this may finally be the market crisis that forces Spain to request a bailout, which they’ve been reluctant to do.
From O’Hagan’s note:
Maybe another mini crisis for Bonos will spark Germany agreeing to entertaining OMT and ESM purchases. But first we have to endure the calvary of a sharp sell-off.
We don’t expect that the market will be able to accomplish all the move in a day. In Portugal we saw successive rounds of selling as investors adjusted to the sub investment grade ratings. And we doubt that the market quite understands the gravity of the rating decisions just yet. Also around a quarter of holders of SPGBs are still non resident. That has come down a lot. But the move has more to go over the coming days.
So be wary of stepping in to buy SPGBs, on the first signs of stabilisation. The only signal worth watching is when OMT and ESM buying start…
However, the ECB reiterated at its most recent meeting that it would not provide OMT assistance to countries that didn’t have full access to bond markets for government funding. So it seems like a bit of a catch-22.